Gov. Tim Walz is dramatically scaling back proposed tax increases and boosting tax relief in his state spending proposal, responding to a state economy that is on the mend more than a year into the COVID-19 pandemic.

In a revised two-year budget plan released Thursday, Walz cut back nearly $1 billion in tax increases he'd previously proposed for cigarettes, large estates and corporations. But he's still calling for a new fifth-tier income tax increase on the state's highest earners. At the same time, he wants to boost tax relief to nearly $1 billion, calling for expanded tax cuts for working families, renters and some businesses and unemployed workers who received federal aid during the pandemic.

"We know that our students, working families, and small businesses have borne the brunt of this pandemic," Walz said in a statement from quarantine after exposure to a staffer on Monday who tested positive for the virus. "That is why, with the recent good news that Minnesota now projects a positive budget balance, we're recommending additional investments to support working families, ensure students catch up on learning, and help small businesses stay afloat while driving economic recovery."

The governor revised his budget after the February economic forecast showed that a $1.3 billion budget deficit had flipped to a projected $1.6 billion surplus. But Walz's proposal is expected to change yet again following the federal government's recent passage of the $1.9 trillion stimulus package, which will send nearly $2.6 billion into the state's treasury. Walz didn't factor that one-time aid into his new budget because state officials are still awaiting guidance on how that money can be used.

His revised plan lowers a proposed increase in the state's corporate franchise tax. It no longer taps $1.5 billion from the state's budget reserve, but it does propose to spend more to help schools cover losses due to the pandemic, expand tutoring services and improve disciplinary practices.

The DFL governor must find agreement with the divided Legislature, where Republicans in control of the Senate have pledged not to raise any taxes this year. Republicans reaffirmed that pledge this week in their own broad budget targets, which include no tax increases, $591 million in tax cuts and a 5% reduction in government administrative costs.

"He still wants to raise taxes. Can you believe that? When you think about all of the billions of billions of dollars coming in from the federal government, and our $1.6 billion surplus, he still wants to raise taxes," Senate Majority Leader Paul Gazelka, R-East Gull Lake, said in response to Walz's proposal. "We've got to work together with the governor, but it's not to raise taxes, it's to pass a balanced budget that works for Minnesota."

Walz's revised budget did signal some movement toward Republicans on tax relief on unemployment benefits and for businesses that received forgivable loans from the Paycheck Protection Program to keep employees on payroll. Those loans are not taxed at the federal level but they are at the state level unless lawmakers act this year.

Walz is proposing that the first $350,000 in forgiven PPP loans isn't taxable income, which the state revenue department estimates will cover approximately 90% of loans distributed to businesses in Minnesota. He also wants to eliminate taxes on up to $10,200 in pandemic unemployment benefits for individuals. The state estimates that will benefit more than 500,000 households with an average tax break of $486.

The Senate recently passed a proposal to make all PPP loans tax-free and cut taxes on some unemployment benefits. House Minority Leader Kurt Daudt, R-Crown, said the governor should exempt all PPP loans from taxes.

"Taking money from struggling businesses is indefensible when state government is flush with cash," Daudt said. "We have billions of dollars available to fully protect workers and businesses from unnecessary tax hikes, and ensure that government is not profiting off relief dollars intended to help Minnesotans."

House Democrats are scheduled to release their budget target numbers on Tuesday. The Legislature and Walz will aim to set the next two-year budget before the regular legislative session ends May 17, though lawmakers have routinely gone into overtime sessions to finalize a deal.